David Solomon is the recipient of the 2016 Peter Hilton Founder’s Award
Martin Okner, ACG New York Chairman: The consumer and retail industry right now have changed at a rapid pace as a result of the explosion in e-commerce, and particularly mobile commerce over the past year, leading to 40% of all e-commerce actions being driven by some form of research done on a mobile phone. As we look at that dynamic in the consumer industry, how does that change your approach in terms of sourcing engagements? Are you seeing different types of companies coming to the table for you and how does that affect private equity as an industry with regards to the rise of e-commerce?
David Solomon: We are very active in e-commerce and multichannel retail, and have completed many of the significant transactions in the sector such as Zappos, Buy.com, Oriental Trading, Sundance, and Fingerhut. While each company in the sector began in one channel such as stores, catalog, or pure e-commerce, there are almost no pure models anymore – they are all moving multichannel.
Amazon, along with the rise of the Internet, has completely disrupted retail and you’re seeing the traditional bricks and mortar department stores and some of the big box retailers suffering. As a result, we think there will be a long-term decline in store square feet devoted to retail in this country.
So what this has caused is a relentless selection of new winners and losers. The winners fall into two camps: there are a few gigantic retailers who are very efficient selling third-party goods, including Amazon, Wayfair, Walmart, Target and a few others. Walmart is doing the same large-scale strategy at the store level, but has still not kept pace on the Internet. The other camp of winners we’ll classify as proprietary specialty retailers, which have developed their own unique brands with proprietary products. These companies design their own products with a distinctive look and feel that creates a cohesive lifestyle. They can be very successful and grow rapidly. Oftentimes, they are mix of multichannel with e-commerce, catalogs and stores. These are where the retail action is right now in the middle market. So at Lazard we are hunting for exciting new concepts, some often growing double digits, in a world where specialty retail and manufacturing start to converge.
This convergence is interesting, starting slowly and gathering steam: Retailers started shifting to their own products, beginning small with 10% private label but many have expanded that to 75% or 80% private label. As they have made that shift, they design the product in-house and are selling merchandise under their brand. It’s no longer private label because they design and outsource the manufacturing. So you have a convergence between designer/manufacturers and retailers who are going direct to the consumer, which disintermediates the distributors.
Convergence is now everywhere, and businesses are crossing over those formerly safe boundaries and accepting channel conflict as normal course. Traditional consumer product manufacturers have websites and sell directly to consumers, competing with their retail customers and distributors. Retailers design and manufacture their own products, competing with their traditional suppliers.
The disruption of Amazon and changing consumer tastes have fragmented once stable markets. Convergence is intensifying competition, which means that we, as bankers, have to become more nimble and constantly reinvent our practice. It also means we need to be able to advise our clients on the impact of this incredible rate of change.
Martin Okner, ACG New York Chairman: There have been challenges within the iconic mall business. What do you think about the mall business over the long term? Are malls going to become extinct or are they going to evolve into these new lifestyle centers that you see popping in Florida and other places? How do you see the dynamics changing with shopping malls in the future?
David Solomon: I used to be a shopping center developer before getting into investment banking. For starters, I think shopping malls will experience shrinkage of overall square footage as they lose market share to e-commerce. You’re going to see an increasing proportion of service providers and experiential retail as opposed to pure product providers. They’ll be places that you have to go to and cannot order online, for example places like Massage Envy or Hand in Stone spas, hair salons, and fitness centers.
There are some interesting new concepts like Bonobos, a menswear business that started as a pure online retailer focused on fit, and then started opening stores with a very different model called Guideshops. You make an appointment to meeting with a fashion consultant/salesperson to experiment with different looks, confirm fit and purchase. There is no inventory in the store to take home – your purchases are shipped from a warehouse to your home directly. They are growing rapidly, and represent a new service/experiential concept that is the new face of retail.
In these disruptive times, some traditional retailers are going to lose market share to the Internet and this is going to increase vacancy rates. When a mall loses 20% or 30% of its tenants, it starts a downward cycle on mall traffic, and sales per square foot go down for everybody. Then you have more store closings and the downward spiral accelerates. There will be some malls that go through that difficult down cycle.
However, there are always going to be some very highly-successful, focused specialty malls. These centers have a concentration of high-end retailers with unique, proprietary products and premium positioning that is differentiating as I mentioned earlier, and these stores have a long-term future.
There’s a lot of interesting things going on in consumer banking. One interesting change at Lazard has been to shift our coverage away from a channel focus. We used to think of ourselves as retail bankers, and more specifically e-commerce and direct-marketing bankers, which has always been a traditional focus for us. Then we moved into direct-selling, and sold companies such as Silpada to Avon and Rexair to Jarden.
Today, we think vertical end markets are more important. Channels are a less important distinction because most consumer brands are going omnichannel to one degree or another. Vertical markets means separate ecosystems like women’s apparel, health and wellness, or pet products. Last year we hired a new senior middle market banker, Nate Pund, who focuses on active/outdoor. He’s one of the top bankers in the country in that very narrow focus of fitness and recreation and it crosses all channels, whether manufacturing, retailing or distribution. It’s all within the active outdoor ecosystem.
We have a senior middle market banker, Ryan Hays, focused on pet products, pet food, pet goods, and pet services regardless of channel. Under our Group Head Eric Roth, we’ve actually merged the middle market consumer practice with retail and not differentiated. We have a separate middle market food vertical that David Iverson runs. He coordinates very tightly with our consumer retail group, but food is generally its own ecosystem as well. And again, that covers things from agriculture all the way through to food processing, branded products and supermarkets.
Martin Okner, ACG New York Chairman: That makes sense given the nature of consumers looking for highly specialized, highly focused products so I could see why you would organize your team that way.
In the phase of these dynamics, can you highlight one or two transactions over the past few years that you’re most proud of at Lazard and really what led to those being your really showpiece deals?
David Solomon: That’s a touch question because there are so many interesting businesses we have advised. I’ll start with multichannel retail because we’ve been discussing that area of focus. Fingerhut, in Minneapolis, was a very large business at one point that was acquired by Federated Department Stores, then fell on hard times and was actually closed down. It was later restarted with support by Bain Ventures and Battery Ventures. When we sold it for them under its new name Bluestem Brands, it was nearly a billion dollar topline business again. It was a very complex and interesting deal because Bluestem sold a full-line of consumer products coupled with credit so that it could reach consumers who don’t have access to traditional credit. The business grew rapidly because of that unique differentiation from the Amazons of the world.
Silpada is a direct seller of high-end custom jewelry, which we sold to Avon for $650 million back in 2012. It was a memorable experience working with the Kelly and Walsh families and helping them achieve their vision of a permanent home for the company. Unfortunately, we received a call a few years later by the founders who asked for our help as the company was facing tough times as part of the merged entity. We advised them on buying back the business for a fraction of the purchase price.
At Lazard, the middle market advisory practice works with companies usually under one billion in value. Yet in all our transactions, we bring to bear the full expertise and network of Lazard, which often means teaming up with large-cap bankers to seamlessly deliver the whole firm. It’s really bringing the right resources at the right time to each situation.
An example of this collaborative approach is Emerald Performance Materials, a transaction that was a divestiture by Sun Capital. We brought in Richard Whitney, Global Head of Chemicals, and our European and Asian chemicals team to engage with all the big buyers globally. The large-cap bankers made sure that the major chemical companies were made aware of the opportunity long before we launched the fast-paced auction process so that we could address these questions of strategic fit.
Using the Lazard network is phenomenal. It provides insight into strategic buyer planning and high-level access to decision makers early in a sale. This is different than what our competitors do, which is to send an e-mail to the buyer’s corporate development team and hoping they can push the idea upwards to the CEO.
The other strategic differentiation I’m very proud of at Lazard is shifting toward highly-focused industry specialization. I’ve mentioned our several deep consumer verticals, and we have a number of other deep verticals such as chemicals, packaging, engineered industrials, transportation & logistics, healthcare services, business services and educational services & technology. Each of these verticals is much narrower than our competitor’s typical coverage areas. We also have product groups including a big restructuring practice and debt placement capability. We enjoy a wide range of upper middle-market transactions, great access to buyers, deep industry teams, and it has been a very effective strategy.
Martin Okner, ACG New York Chairman: It’s interesting as I look broadly across the consumer industry, there’s so many examples of large companies looking at relatively small brands with a lot of high potential and unique positioning, so adding to what you were mentioning about your structure in terms of really working mid-cap, large-cap and really being one Lazard, I can see a very distinct value proposition there. It’s an interesting discipline to look for in a candidate, what would your advice be to a recent MBA grad who is getting into investment banking or private equity in light of current dynamics? What would be your advice to them in order to prepare themselves for entering the industry?
David Solomon: It takes more work today to acquire talent from the MBA schools and other talent pools, and it is a constant source of discussion amongst investment banks, including Lazard, Goldman Sachs, Morgan Stanley and others. How do we attract talent? We are at a time where it now appears more exciting for Millennials to work for Google or other Silicon Valley alternatives. Millennials are culturally different and are changing the whole landscape of talent development.
To a young person who is interested in financial services, I can say banking is an amazing career that stretches and challenges you in every way. I’ve had three careers: I was an architect, a real estate developer and then an investment banker. This is the one career that used every aspect of my capability to a maximum and I’ve never been bored, and always been challenged. That’s because you have to be analytical to understand how businesses work. If you are intellectually curious, this is a fun business for you, because you get to experience how the world works and understand why some companies succeed and others fail. There’s nothing like banking to see a lot of examples of business models and to explore what makes the world work.
This is also a career where you can actually change the course of events by the force of your personality. So your vision and your ability to manage interpersonal situations are critical so that you can overcome problems between buyer and seller to hold things together and move things in the direction that you think has logic and economic sense to it. It’s a career where you need to take a position, and represent a particular position. It requires a deep understanding of negotiation.
In this career, you must develop a powerful network. This means you have to be very good with people, and develop real interpersonal relationships. You must know their kids, have dinner, or play golf. It means spending real time with your relationships, whether it’s private equity, corporate buyers, and prospective sellers. It’s who you know and how deeply you know them and how much they like you. Those sort of emotional connections are very essential.
Finally, you have to be proactive and intense. You will be more successful if you can anticipate and look around corners to see where events are likely heading. If you can be proactive you will lead the processes and lead change instead of reacting all the time. These are things that as an individual, as a young professional, you can make a difference.